Is the U.S. economy poised for a third-quarter rebound?
That’s a forecast that some analysts are making, which would spell trouble for the bond market, which has been predicting the opposite. But the fixed-income set suffered a mild loss of confidence in Tuesday’s session, and in the process lent credence to the idea that the rate of growth in GDP for the third quarter will top the second-quarter’s pace.
The yield on the 10-year Treasury Note reversed course yesterday in no uncertain terms, rising to 4.78%, up from 4.73% on the previous close. It was the biggest one-day selloff in the 10-year in nearly two months (bond yields and prices move inversely).
Among those leading the charge for reassessing the prospects for economic growth is David Gitlitz, chief economist at TrendMacrolytics. In a note sent to clients yesterday, Gitlitz warned that the recent rally in the bond market was destined for a rude awakening as evidence of a third-quarter revival mounts in the coming weeks. The real opportunity in bonds, he wrote, “is on the short side — an opportunity that will crystallize when the evidence of reaccelerating growth and continuing inflation pressures become utterly unmistakable, and when there can be no further denial that the Fed’s next rate move will be higher, not lower.”
For the moment, however, the reported numbers show only an economy that’s slowed considerably. The quarter-on-quarter rise in U.S. GDP was 0.7%, or half as fast as the first-quarter’s pace. But the slowdown is set to reverse course in the third quarter, or so the OECD projects, with GDP advancing by 0.9% once the final tally for the July-through-September is published.
The notion that the economy is set to bubble a bit more than expected has also been getting a boost lately as oil prices have tumbled. In mid-July, crude briefly broke above the $80 a barrel mark–an all-time high. Yesterday, the October contract for oil closed in New York at just over $68.
The latest catalyst for thinking that oil may fall even further is the news of a major oil find in the Gulf of Mexico–a discovery that some say may boost U.S. reserves by 50%. Even if that optimistic projection turns out to be true, it won’t have much impact on reducing America’s dependence on foreign oil. But for the moment, the prospect of lower energy prices supports the belief that third-quarter economic growth could surprise on the upside.
Perhaps, although the slowdown in housing remains the big unknown. Even most optimists on the economy concede that the reversal of fortunes in housing is keeping expectations in check. And for good reason. The latest warning sign for real estate came by way of yesterday’s update from the Office of Federal Housing Enterprise Oversight (OFHEO), which reported that home prices “fell sharply” in the second quarter. “Appreciation for the most recent quarter was 1.17 percent, or an annualized rate of 4.68 percent. The quarterly rate reflects a sharp decline of more than one percentage point from the previous quarter and is the lowest rate of appreciation since the fourth quarter of 1999,” an OFHEO press release advised.

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Europe is hot, according to S&P/Citigroup Global Equity Indices.
For 2006, European Emerging equities lead the horse race through yesterday, delivering a 34.5% total return, S&P/Citigroup reports. Europe overall hasn’t done all that bad either, posting a 22.2% return this year. But as the chart below reveals, stellar returns haven’t been standard around the globe. Even so, the bottom performer (Mid-east and Africa) managed to eke out a 1.6% rise.

Past performance is no guarantee of future returns, as they say, although it does provide some perspective on what may come next. Perspective, such as it is, seems like a timely subject now that the summer is unofficially over and thoughts turn again to work. And just in time to greet the returning hordes to their desks comes a fresh forecast from the OECD, which has published a new outlook on the G7 economies. The outfit opines that GDP growth for the biggest economies will remain steady in the third quarter compared to the second, although signs of slowing will become more evident, if only slightly, once the fourth quarter arrives.
With that in mind, where does value reside in the world equity markets? As always, coming up with an answer is complicated and therefore risky endeavor. But a 1,000-mile journey starts with the first step. With that in mind, we begin by looking at the globe’s equities by dividend yield. On that score, Asia Pacific ex-Japan offers the best relative payout at around 3.3%, or nearly twice as high as U.S. equities.

There is, of course, more than one way to define value. As such, here’s a look at three more fundamental rankings of world equity markets (return on equity, price-to-cash flow and trailing 12-month price-to-equity ratios), all courtesy of data from S&P/Citigroup Global Indices.

The new new bull market in bonds that began in early July picked up steam yesterday, pushing the yield on the benchmark 10-year Treasury down to 4.73%–the lowest since March. As recently as late June, the yield was nearly 5.25%.
A casual observer might wonder if something dramatic had changed in the last two months to convince bond traders to buy, buy, buy. Yes, there’s been more than a little evidence that the real estate boom is becoming something less, although the jury’s still out on whether that will deliver a fatal blow to the economy or just a mild slap on the wrist.
Adding to the complication of figuring out what lurks (or doesn’t) around the corner is this morning’s update on August employment. For those looking for decisive evidence that an economic slowdown of some magnitude is upon us, the latest batch of numbers is sure to disappoint. The jobless rate, for instance, slipped a bit last month to 4.7%, or near the lowest levels in the past five years.
Meanwhile, the consensus outlook predicted a rise of 125,000 in nonfarm employment for last month, according to TheStreet.com; the actual number came in slightly higher, at 128,000, which is also higher than July’s 121,000 increase.
The fact that the labor market continues to hold up may be frustrating for some who are expecting the apocalypse, but numbers are numbers. And that includes the fact that the nonfarm payroll reached yet another record high last month: 135.5 million. True, the August advance is up only 1.3% from a year ago–the slowest annual pace of increase in the monthly numbers since last October, as illustrated in the chart below. Nonetheless, the economy is still growing and creating new jobs, and at a rate that, while hardly extraordinary, is still within the range of recent history.

Adding yet another layer of optimism to today’s employment report is the implication that inflation isn’t accelerating. That, at least, should hearten the bond bulls and extend fresh credibility to the Fed’s recent decision to pause on hiking interest rates. The tepid rise in hourly earnings last month suggests that wage pressure on prices has moderated, at least compared with the much-higher pace posted in July.
For the moment, signs of a slowdown or worse have been put on hold. Tougher times may in fact still be headed this way for the economy, but bond traders will have to decide if they’ve overplayed their hand in betting that the American jobs machine is set to take a tumble. The data gods are sitting on the fence, and bulls and bears alike must sweat it out until clear signals emerge. Suffice to say, clarity is arriving at its own sluggish pace.